“Large moves follow large moves and small moves follow small moves.”
-Jim Gatheral
The beauty of mathematical statements is that they often simplify the complex. The aforementioned one-liner by Gatheral comes from a foundational book I read a long time ago (published back in 2006) that I often cite called The Volatility Surface.
Obviously “large” and “small” moves happen frequently. The particular duration he was discussing with that one-liner was super-short-term (i.e. local or instantaneous volatility).
Like everything we model @Hedgeye Macro, instantaneous (i.e. in the moment) volatility is measured and mapped stochastically. As Jim taught me, “it’s unrealistic to suppose that instantaneous volatility wouldn’t jump if the stock price were to jump” (pg 68). The key is to know when to fade those Vol Spikes.
Back to the Global Macro Grind…
Since I never really “know” anything for sure, during Vol Spikes I’m constantly refreshing my Vol of Vol models. The amount of times I “hit the button” (refresh) could potentially blow your mind.
Especially in an intense OODA loop of market or “clock” time, that allows me to probability weight every incremental decision.
If A) you aren’t doing things incrementally (I generally execute in 25 to 50 basis point increments of my capital at risk) and B) you aren’t re-modelling things in real-time stochastically, we don’t have the same decision making process.
Why do it incrementally?
A) Going “all-in” too fast can get you killed, fast
B) Going in, incrementally, sometimes tells you to get in faster
C) Going in, incrementally, sometimes tells you to get the f out
You don’t have to do anything the way I do it, but I’ve learned that I have to constantly coach it the way I play The Game.
Having an objective, math-based, decision making process is the only way for me to reduce the probability of making a big mistake at THE particular time in The Game (clock time) that matters most.
Using yesterday’s Oil Vol Spike as an example:
A) Oil Volatility (front-month OVX) went from 37 to 48 in less than 1-day of clock-time
B) Historically speaking in #Quad2, that happens, rarely … so I went in (started buying)… and
C) I because I went “in” too early… I slowed it down… then went in again, faster, into day’s end
Going “in” on what? I was buying a bunch of single stock names that I don’t want you to confuse with the broader example I’m trying to get through.. To do that it’s easier to just tell you what I did in the headline Commodity (Brent Oil) and Sector Style (XLE):
A) Since my MAX position for a Commodity is 4% of my capital, I ultimately got to 50% of my max by days end
B) Since my MAX position for a Equity ETF is 6% of my capital, I ultimately got to 67% of my max by days end
Why 2/3 of the way instead of 1/2 of the way? Simple Answer: Oil’s Vol Spike was above my TREND Signal level and Energy’s (XLE kind) wasn’t. For reference @Hedgeye TREND for Oil Vol = 48.36.
Why not go all-in? I’m not running some bloody “valuation” model here, folks. There isn’t a “fair value” price I go to my MAX at. There’s a volatility of the price.
Since I’m a “buyer on red” first type of player, it took me a looooong time to teach myself to fill the position to my MAX on the way up. As my Mom always taught me, “sweetheart, you can do this.” Lol
How does that work, in practice?
If Oil’s Vol Spike ends up proving to be episodic-and-non-TRENDING in the coming 2-3 market days, Ill fill up my tank to max, but do so, like you do at the pump, incrementally.
What if it isn’t episodic? Well, that’s easy. It’s the beginning of the end for #Quad2… Oil’s Vol Spike will start to TREND… Oil Vol will eventually ramp > 60… and I’ll get my teeth kicked in, publicly.
If I don’t use the same process to get out, incrementally, that is.
Immediate-term @Hedgeye Risk Range with TREND signal in brackets:
UST 10yr Yield 1.51-1.73% (bullish)
SPX 3 (bullish)
RUT 2 (bullish)
NASDAQ 12,645-13,798 (bullish)
Energy (XLE) 49.03-54.96 (bullish)
Financials (XLF) 33.55-35.30 (bullish)
Shanghai Comp 3 (bearish)
DAX 144 (bullish)
VIX 17.71-23.96 (bearish)
USD 91.16-92.23 (bearish)
GBP/USD 1.381-1.404 (bullish)
Oil (WTI) 59.77-67.96 (bullish)
Copper 4.00-4.21 (bullish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
